Joining the other nearly 1 million Australians to run a business from home? It can be really fun and rewarding. That is, if you are well prepared for what’s ahead of you and ready to learn what is not your area of expertise, such as numbers.
That’s why you are here 🙂
So, as a home-based business owner, what kind of home office deductions can I claim? How to calculate them? And what should I do to comply with the rules?
This post is a guide for claiming home office expenses as a home-based business only. If you are an employee working from home, please check out my other post here for employee home office deductions.
The general rule on claiming home office expenses
It is straightforward: if you incur expenses from running your business from home, you can only claim deductions for the business part of the expense. Private portions are NOT deductible.
And what are the specific guidelines?
In order to interpret a tax ruling or legislation correctly, we need to understand its building blocks first.
The ATO likes to refer to these expenses as home office expenses. We also call them working from home expenses from an employee’s point of view.
Running expenses Vs Occupancy expenses
There are two broad types of home office expenses:
Running expenses: increased costs from using the facilities within the home for your business or work, including electricity/gas charges for heating/cooling, lighting, cleaning costs, phone and internet bills, depreciation and repairs on office equipment, furniture and furnishings.
You can claim running expenses regardless of whether you work from home as an employee or your home is the primary place of your business, but of course, for the work/business portion only.
Occupancy expenses: what you pay to own or rent your home, including rent, mortgage interest, water rates, council rates, land tax and home insurance premiums.
To claim occupancy expenses, part of your home must qualify as your primary place of business. Otherwise, NO occupancy expenses claim are allowed.
The question is: how to qualify as a place of business?
ATO TR 93/30 has listed a number of factors that may indicate that a part of a home has the character of a place of business, while, unfortunately, none of them is necessarily conclusive on its own:
- the area is clearly identifiable as a place of business, for example, you have a sign identifying your business at the front of your house
- the area is not readily suitable or adaptable for use for private or domestic purposes in association with the home generally;
- the area is used exclusively or almost exclusively for carrying on a business (a dedicated area); or
- the area is used regularly for visits of clients or customers.
A place of business will exist only if all three conditions below are met:
- it is a requirement inherent in the nature of the taxpayer’s activities that the taxpayer needs a place of business.
For example, as a freelance portrait photographer, Nick needs a studio with a great lighting system for professional photo shooting.
- the taxpayer’s circumstances are such that there is no alternative place of business and it was necessary to work from home.
Nick doesn’t have a rented studio for work, so he has to work from home.
- the area of the home is used exclusively or almost exclusively for income-producing purposes (could be either business or employment).
Nick’s home studio is a separate room specially set up for photo-shooting, and his use of this room for private purpose is minimal.
My own comments on establishing a place of business:
In most cases, if you are running a business, and you genuinely need a workspace, you will be highly likely able to claim that space as a place of business in order to claim occupancy expenses, that is, if you have set that space up as a dedicated work area, which is not ready for private use. For example, working from your living room will not suffice as having a dedicated area.
Ok, now let’s assume that you have met all the criteria and established the fact that part of your home is the primary place of your business. Therefore, you are eligible for claiming both occupancy costs and running costs.
Next is the math.
How to calculate occupancy costs for your home-based business
Calculating occupancy costs is relatively simple. It is based on the floor area size of your dedicated work space in comparison to the total size of your home building.
Eric is a GP who lives in a 3 bedroom house. He uses the room close to the front of the house as his clinic, where he sees his patients regularly. The clinic room is 25 m²
and the whole house is 125 m². He pays rent $2,000 monthly and home insurance $1,000 annually. He took 1 month holiday during the 2019-20 financial year.
- Business percentage for occupancy = floor size of his clinic room ÷ total floor size of his house = 25 ÷ 125 =20%
- Occupancy claim for rent = 20% x ($2,000 x 11 months) = $4,400 (1 month holiday period excluded)
- Occupancy claim for home insurance = 20% x ($1,000 x 11/12 months) = $183 (1 month holiday period excluded)
- So Eric’s total occupancy expenses claim for business = $4,400 + $183 = $4,583
How to calculate running costs for your home-based business
The methods of calculating running costs for home-based businesses are the same as in claiming working from home expenses for an employee. Including the ATO’s newly introduced method for Covid, there are three methods available:
- The Shortcut Method (only available between 1 March 2020 and 30 June 2021)
- The Fixed-Rate Method
- The Actual Cost Method
As a home-based business, which has a dedicated work area, you can choose whichever method to work out the best outcome for your home office claim on running costs.
The Shortcut Method (80 cents per hour)
In light of an increasing number of people working from home since the outbreak of Covid-19, the ATO introduced this shortcut method in an attempt to simplify how home office expenses are calculated and reduce the compliance requirements.
This method is temporary and can only be used to work out your work from home deduction:
- between 1 March to 30 June 2020 in the 2019–20 financial year
- for the 2020–21 financial year.
which means, for the 2019-20 financial year, between 1 July 2019 to 29 February 2020, the shortcut method is NOT available, and you can only choose to use the fixed-rate method or the actual cost method for this period.
80 cents x total hours worked from home
- It’s a shortcut method, so it’s simple to use.
- You don’t have to have a dedicated work area to use this method.
- You don’t need to keep your receipts. All you need is a diary or timesheet that shows the hours you worked from home.
- If you use this method, you can’t claim any other expenses for working from home as the 80 cents formula covers ALL your working from home expenses, including: phone, internet, the decline in value of equipment and furniture, electricity and gas for heating, cooling and lighting.
- 80 cents per hour can’t really cover your costs if you use your home office heavily in terms of electricity and other expenses such as phone, internet.
The Fixed-Rate Method (52 cents per hour)
52 cents x total hours worked from home
to cover the following running costs only:
- the decline in value of home office furniture and furnishings – e.g, a work chair
- electricity and gas for heating, cooling and lighting
- the cost of repairs to your home office equipment, furniture and furnishings.
On top of which, you can claim below business-related running expenses separately with the actual method:
- phone expenses
- internet expenses
- computer consumables and stationery – such as ink
- the decline in value of equipment – such as phones, computers and laptops. Bear in mind that, as a small business, you can claim most of these items immediately rather than have to depreciate them as required for working from home employees.
- This method would be a better option, compared to the shortcut method, if your other running costs than the 52 cents covered ones are high, as they can be claimed separately.
- It is still a simpler method compared to the actual method.
- you have to have a dedicated area to use this option. That is, if you can’t establish part of your home is a place of business in the first place, this method is not available for you.
- not only do you need to keep a diary or timesheet to set out your hours worked from the home office (although a representative four-week diary is also acceptable), you also need to keep all the receipts and show evidence of business percentage for all other expenses (e.g, phone, internet, laptop etc) claimed outside of the 52 cents formula.
The Actual Cost Method
Basically, you can claim whatever costs actually incurred for your business.
1. For utilities (electricity and gas) expenses, as we have assumed that you have already satisfied the “place of business” condition and do have a dedicated workspace, you can either claim on a floor area basis, or calculate actual power usage for each lighting, appliance or equipment for business use.
- on a floor area basis:
Total home utility bills x (workspace m² ÷ total home m² )%
- itemised power usage:
- identify which individual items (lighting, equipment or appliances) are used for business
- for each item, find out its power usage per hour (kW/h)
- work out the average cost per kW per your utility bill
- use your records to calculate total hours worked from home for the period/income year
- work out time percentage of your total working from home hours for each item
- your business claim on utilities = SUM of [each item’s power usage kW/h x cost of each kW x (% of total working from home hours used for that item x total working from home hours) ]
It is a bit complex. I would normally use the floor area % option rather than the itemised method unless my office energy consumption level is much higher than the rest of the home.
2. For all other running expenses, such as phone, internet, office furniture etc, simply work out the business percentage then times total costs.
you can claim more deductions than the fixed-rate or shortcut method, if you work long hours at home, your workspace floor area is big, or you’ve invested large amounts on home office equipment and furniture etc.
- complicated if using the itemised power usage calculation. But it may be worthwhile if the outcome is much better than the other methods.
- to substantiate the hours, you need to keep a diary or timesheet to record the actual hours worked or for a representative four-week period only to show the usual pattern of working from the home office. You also have to keep all the receipts and evidence of business percentage for all your claims.
Recommendation for record-keeping
To keep your options open at year-end, ensure to always keep all the receipts and records showing how you’ve worked out the business percentage unless you are certain that the actual cost method will not be your option.
An example – compare to work out the BEST method to claim running costs:
Rita runs a sole trader business in physiotherapy, usually working from Monday to Thursday, from a rented space in a centrally managed health centre in Hurstville, Sydney. She has also set up a separate area at home for treating clients on Fridays and for doing some office work occasionally. From 1 July 2019 to 29 February 2020, based on her diary, she worked out her working from home hours was 10 hours per week except for the 4 weeks holiday taken during the Christmas time.
Since 1 March 2020, due to the Covid situation, the health centre got shut down, and she started to run her practice from home full time- 37.5 hours per week. She also purchased a new work chair (90% work usage) for $256 in late March.
Her monthly home internet bill is $59. She determines her home internet business usage was 10% before 1 March 2020 and 60% after.
Also, Rita’s electricity usage records are as below:
- used her air conditioning for 50% of the time she spent working from home – the air conditioner uses 2kW for cooling and heating per hour.
- used two 12 watts LED lights in the treating room whenever she is working.
- used her laptop (for practice system management, research, and recording treatment details) whenever she is working from home – the laptop uses 50 watts per hour.
- she pays 25 cents per kW per her electricity bill
To prepare her 2019-20 income year tax return, Rita needs to compare these three methods to work out the maximum claim for her sole trader business.
Therefore, Rita would go for the fixed rate method as it gives the highest claim amount.
Also note, if we know Rita’s home office floor area size compared to her whole home size, we can also calculate the electricity costs based on the floor area percentage to compare.
Give yourself a pat on the back. That was a massive read.
In a nutshell, besides running costs, you can also claim the business portion of occupancy costs only if you’ve set up a dedicated area to run your business from home, and this part of your home qualifies as the primary place of your business.
In terms of calculations, it can get a bit tricky to work out the deductible running costs, especially when you are using the actual method.
So if you are not sure about whether your home office qualifies as a place of business, or you are confused about how to calculate the running costs, you may want to consult your tax agent or contact us.
Please note that this post is intended to be a general guide only, and should not be seen to constitute legal or tax advice. Where necessary, you should seek a second professional opinion for any legal or tax issues raised in your personal or business tax affairs.